man typing the word Annuity Under existing law and regulations, plan fiduciaries have to consider the long-term viability of an insurer before including their products in an investment menu. The new safe harbor would shift that onus to insurers. (Photo: Shutterstock)

For years prior to the passage of the Pension Protection Act of 2006, sponsors of defined contribution plans were aware of automatic enrollment's potential to vastly improve retirement plan design.

But adoption of the feature was relatively slack, notwithstanding the persuasiveness of behavioral economics research correlating auto-features with higher participation rates in retirement plans.

“Sponsors were hesitant to adopt automatic features because they worried they would be considered as illegal garnishments of wages in some states,” explained Bob Melia, executive director of the Institutional Retirement Income Council. “That sounds ridiculous now, but it was true at the time.”

The PPA proved to be an immediate elixir. “Sponsors' worries over their fiduciary exposure was taken off the table, and we all saw what happened with auto features from there.”

Now, Congress is positioned to pass another landmark retirement bill.

The bipartisan SECURE Act passed out of the House Ways and Means Committee by unanimous vote this week with vows from the committee's leadership to have a bill on President Trump's desk by the end of the year.

In the Senate, the virtually identical Retirement Enhancement and Savings Act was reintroduced by Finance Committee leadership, who are said to be eager to act.

Annuity Selection Safe Harbor

Provisions that address lifetime income options in 401(k) plans are a cornerstone of both bills.

An annuity selection safe harbor for plan sponsors addresses what a 2016 report from the Government Accountability Office said was a primary barrier to offering annuities in 401(k) plans.

Under existing law and regulations, plan fiduciaries have to consider the long-term viability of an insurer before including their products in an investment menu. The new safe harbor would shift that onus to insurers, and rely on the assurances of state insurance regulators that carriers are adequately capitalized.

Sponsors' monitoring requirements would be met through annual attestations from insurers that they are in compliance with state regs.

“It's a very simple yet elegant solution to the fiduciary risk problem,” said Melia. “I think they got this exactly right.”

The fiduciary relief in the SECURE Act is not unlike what sponsors experienced with auto-features prior to passage of the PPA.

“For years, there's been a lot of talk around the safe harbor,” said Melia. “That's caused a delay in adoption. Sponsors' thinking has been 'if we wait a bit, we may get fiduciary relief'.” Moreover, the drumbeat for an annuity selection safe harbor has highlighted how onerous the existing fiduciary obligations are.

“Now, as legislation offers an easy, prescribed safe harbor, it will knock out that primary barrier to adoption,” just as the PPA knocked out the barrier to automatic enrollment, thinks Melia.

Portability of in-plan annuities

Perhaps as much of a barrier to the adoption of annuities in 401(k)s has been the question of their portability.

“It's a real problem, and it's pointed out to sponsors all of the time,” said Melia.

Under existing regulations, a plan participant who holds an annuity through a 401(k) is left in the lurch if they leave their employer, the plan merges with another through an acquisition, or the plan drops the annuity offering from the menu.

“The legislation says, 'look, if your sponsor no longer offers the guaranteed income product you are in, you now have a qualified distributable event, and if you want, you can keep that annuity and roll it over to an IRA,” explained Melia.

Under existing regulations, annuities have to be liquidated, exposing savers to taxes if they are under the age 59 ½ . Or, another annuity can be repurchased, but possibly under lower-interest rate conditions at greater cost.

And if a participant goes to the retail market, they lose the institutional pricing they had in plan.

“It's as much of a barrier to adoption as sponsors' fiduciary risk,” said Melia. “And a very clumsy approach. But if the law is passed, annuities would not have to be liquidated, and the guarantees are preserved.”

No magic bullet

Melia expects the House and Senate will ultimately harmonize a retirement bill through conference committee, and that it will be passed and signed into law by the end of the year.

Annuities are now offered in about 9.3 percent of 401(k) plans, according to the Plan Sponsor Council of America. Would they become commonplace overnight if a bill passes? Not necessarily, said Melia.

“Opinions differ on the significance of these bills on in-plan annuities,” he said.

IRIC's membership includes asset managers along with insurance companies, and the Committee is curating relationships with managed account providers.

Even for the most ardent proponents of guaranteed income products, the SECURE Act is not a magic bullet.

“Not in and of itself,” said Melia. “Employers will only adopt—and should only adopt—retirement income solutions if it makes their plan a better human resource tool.”

Employers should always ask if their plan attracts and retains talent, and whether the plan is a win-win—for employer and participants—in getting people to a secure retirement when they want.

“Unless, or until plan sponsors are thinking like that, I don't think you will see widespread adoption,” said Melia.

Still, the value of the annuity provisions in the SECURE Act is real. As more sponsors, and the country as a whole, engage in a “financial wellness” conversation, consideration of what role annuities play in 401(k) plan design is bound to grow. “We're at a point now where retirement income is viewed as a component of financial wellness,” said Melia.

The SECURE Act's portability provision could be implemented immediately. The annuity selection safe harbor would take a bit more time, as would more product rollouts from insurers.

But if annuitization is right for a retirement saver—“it's not for everyone,” says Melia—there's little doubt as to whether consumers could benefit from access through the workplace. Fees on in-plan annuities run about half what they do in the retail market.

And for those for whom it is the right solution, “they are far better off doing it through the DC market,” said Melia.

READ MORE:

'Large employers can lead' in benefits space

Study: Majority of Americans prefer lifetime income to lump sum

Pushing back against annuities in 401(k)s

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Nick Thornton

Nick Thornton is a financial writer covering retirement and health care issues for BenefitsPRO and ALM Media. He greatly enjoys learning from the vast minds in the legal, academic, advisory and money management communities when covering the retirement space. He's also written on international marketing trends, financial institution risk management, defense and energy issues, the restaurant industry in New York City, surfing, cigars, rum, travel, and fishing. When not writing, he's pushing into some land or water.